LatestStories

Living Economics

Wednesday, May 30, 2012

My love affair with economics began in the fall of 1979. The summer prior to that I had experienced the long lines for gasoline, and I was confused and frustrated by the experience for a variety of reasons. Economics erased my confusion and targeted my frustration on the cause of the shortages. I was hooked.

In many ways, the logic of economic reasoning came naturally to me once I started studying. My first readings in the field were Henry Hazlitt’s Economics in One Lesson and Free Market Economics: A Basic Reader, edited by Bettina Bien Greaves (which included Leonard Read’s “I, Pencil”). These were followed by various essays and excerpts from books by Ludwig von Mises related to the problems of socialism and interventionism and the benefits of the free-market economy, and then Milton and Rose Friedman’s Free to Choose. By the time I finished Free to Choose, I would never think about the world around me the same way. I saw everything through the economic lens—from the most mundane human activities to the most profound. To me, economics is simultaneously the most entertaining discipline in the human sciences and the most important discipline in the policy sciences, as it ultimately answers fundamental questions about human life and death.

Getting Back on Track

I believe that much of modern economics has lost its way, and I am actively engaged in trying to get the teaching and doing of economics back on track. Following one of my teachers—Kenneth Boulding—I use the term “mainline economics” to describe a set of propositions that were first significantly advanced in economics by Thomas Aquinas in the thirteenth century and then the Late Scholastics of the fifteenth and sixteenth centuries at the University of Salamanca in Spain. . . . These insights were further developed in economics from the Classical School of Economics (both in its Scottish Enlightenment version of Adam Smith and the French Liberal tradition of Jean-Baptiste Say and Frédéric Bastiat), to the early Neoclassical School (especially the Austrian version of Carl Menger, Ludwig von Mises, and F. A. Hayek), and finally with the contemporary development of New Institutional Economics (as reflected in the property rights economics of Armen Alchian and Harold Demsetz; the new economic history of Douglass North; the law and economics of Ronald Coase; the Public Choice economics of James Buchanan and Gordon Tullock; the economics of governance associated with Oliver Williamson and Elinor Ostrom; and the market process economics of Israel Kirzner). The core idea in this approach to economics is that there are two fundamental observations of commercial society: (1) individual pursuit of self-interest, and (2) complex social order that aligns individual interests with the general interest.

In the mainline of economics, the “invisible hand postulate” reconciles self-interest with the general interest not by collapsing one into the other or by assuming super-human cognitive capabilities among the actors, but through the reconciliation process of exchange within specific institutional environments. It is the “higgling and bargaining” within the market economy, as Adam Smith argued, that produces social order. The “invisible hand” solution does not emerge because the mainline economist postulates a perfectly rational individual interacting with other perfectly rational individuals within a perfectly structured market, as many critics suppose. Such idealizations would be as alien to Adam Smith as they would be to F. A. Hayek. Instead, for those who “sit in the seat of Adam Smith,” man is a very imperfect being operating within a very imperfect world. Sound economic reasoning, by focusing on exchange, and the institutions within which exchange takes place, explains how complex social order emerges through the aid of prices and the entrepreneurial market process.

The mainline of economics, in my narrative, is to be contrasted with the “mainstream” of economic thought. Mainline is defined by a set of positive propositions about social order that were held in common from Adam Smith onward, but mainstream economics is a sociological concept related to what is currently fashionable among the scientific elite of the profession. Often the mainline and the mainstream dovetail, but at other times they deviate from one another. It is at these moments of deviation that acts of intellectual entrepreneurship are acutely needed by those working within the mainline of economics to recapture the imagination of mainstream economics, getting the discipline back on track.

Social Cooperation

Economics teaches us many things, but to me the most important is how social cooperation under the division of labor is realized. This is what determines whether nations are rich or poor; whether the individuals in these nations live in poverty, ignorance, and squalor or live healthy and wealthy lives full of possibilities. If the institutions promote social cooperation under the division of labor, then the gains from trade and innovation will be realized. But if the institutions, in effect, hinder social cooperation under the division of labor, then life will devolve into a struggle for daily existence. Economics, in other words, gives us the key intellectual framework for understanding how we can live better together.

Teaching Economics

The teaching of economics . . . is not a trivial endeavor. The subject is illuminating and the stakes are high; if we fail in our task as economic educators, then we fail in our job as economists. There is no way around this conclusion. Economics is not merely a game to be played by clever professionals, but a discipline that touches upon the most pressing practical issues at any historical juncture. . . . The discipline of economics illuminates all walks of human life, and as such it is an ambitious science. It explains the doings of man, whether in the marketplace, the voting booth, the church, the family, or any other human capacity. The economic way of thinking is not just one window on the world; it is the only window that deals with man as a human actor. This may sound arrogant to the casual reader, but economics also teaches humility. As F. A. Hayek put it, “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”

The mainline of economic teaching from Adam Smith to Hayek taught not only what economics can tell us but more importantly what it cannot tell us. There are real limits to economic analysis and efforts at economic control. The main reasons economics got off track in the twentieth century are . . . a failure to recognize those limits and a confusion of the policy sciences with the engineering sciences. Based on the knowledge of the physical sciences, the engineering sciences created technological solutions unimaginable to previous generations. My grandparents entered this world when most travel was conducted by horse and buggy; they departed this earth in a world which had not only experienced transatlantic flight but had placed a man on the moon. Since their passing, the Internet has developed and transformed not only the way we communicate but also the way we shop, the way we learn, and the way we form social bonds. These amazing technological advances tend to reinforce the idea that through science men can conquer any and all problems they face.

But even in this case of technological innovation, we tend to forget something vital to the story of progress. Technological knowledge was transformed into useful knowledge through the ordinary business of commerce. Without the guiding role of property, prices, and profit/loss accounting, the gains from innovation would not be realized. The reason for this is simple: Without the guiding signals and incentives of the price system, economic actors cannot sort out from the array of technologically feasible projects those that are most economical to pursue. And absent that economic knowledge, technological ventures will be plagued by a systemic waste of resources.

Description, Not Design

However, there is an even more subtle point to make than the necessity of commerce to guide technological innovation. Commercial life did not emerge through design but instead out of the human proclivity to truck, barter, and exchange with one another. Specialization in production and exchange existed well before economists came up with those terms to help explain that behavior. Economists, in other words, did not invent the economy but rather came to their study with the economy already operating and were tasked with the role of providing philosophic understanding of already existing practice. This is radically different from the civil engineer who designs the bridge to ease travel between Manhattan and Brooklyn. The demand by politicians and the public that economics be more like engineering is perhaps the greatest corrupting force on the science.

But if we accept the judgment that economics cannot play the role of social engineering, we need not be content with economics being purely philosophical. Economics and political economy are capable of generating significant empirical information. The discipline can inform us about how alternative institutional frameworks will impact our ability to realize the gains from trade and innovation. If the institutional framework impedes trade and innovation, then those gains will go unrealized; if the institutional framework encourages those aspects of an economy, then those gains will be realized.

Two Propensities

I often tell students that humankind has demonstrated two natural propensities—to truck, barter, and exchange (as Adam Smith taught); and to rape, pillage, and plunder (as Thomas Hobbes taught us)—and which propensity is pursued is a function of the institutional framework within which individuals find themselves living and interacting. The life experience can be a virtuous cycle of wealth creation and healthier and wealthier lives, or it can be a nasty and brutish hell on earth. So while economics cannot give us exact point predictions, it can, as a science, inform us of tendencies and directions of change as well as the wealth-creating or wealth-destroying capacity of the political economic system.

The mainline of economics explained the operation of the economy not by making heroic assumptions about the cognitive capability of individuals, nor did it describe politics by reference to benevolent despots. Instead, the political economy of Adam Smith to F. A. Hayek takes humans as they are and seeks to find the institutional framework that both constrains bad people so they do the least harm when in positions of power and uses the ordinary motivations of humans and their limited cognitive capabilities to realize social cooperation under the division of labor. The mainline economists found that in the private-property market economy and a constitutionally limited government . . . individuals’ unique knowledge of time and place could be marshaled to realize a peaceful and prosperous social order.

Hubris

What economics and political economy had to guard against was human hubris. Hubris can come in two forms: a hubris that one is of a higher moral character, and a hubris that one is of a higher intellectual caliber than one’s fellow citizens. It is this hubris that Hayek called The Fatal Conceit. The intellectual culture in which Adam Smith wrote was sympathetic to such a critique of hubris. . . . The “man of system”—as Smith termed this hubris in The Theory of Moral Sentiments—was the object of ridicule. Only he would be “wise in his own conceit” or in possession of the “folly and presumption” to believe he should lord over other men in their affairs of commerce.

By the time that John Maynard Keynes wrote The General Theory of Employment, Interest, and Money, something had radically changed in the intellectual culture. Now rather than being an object of ridicule, the man of system was in demand to fix the problems of the vagaries of commercial life and the problems of modern industrial society with unemployment and business fluctuations. Economics since that time has been derailed educationally and as a tool for public policy. It became the handmaiden of the man of system and not the reason to doubt the wisdom of that conceit of men. We have The Economics of Control and not the Common Sense of Political Economy.

Economists are tasked with speaking truth to power, not catering to power. The discipline, from Smith to Hayek, has taught us about the need to limit power to curb the predatory capabilities of mankind. And when we don’t heed its teachings, we don’t overturn the basic results that Adam Smith, J. B. Say, and F. A. Hayek arrived at about the power of the market to create wealth and of politics to destroy it. The twentieth-century experiment with communism reinforces this basic lesson of mainline economics. As Ludwig von Mises put it: “The body of economic knowledge is an essential element in the structure of human civilization; it is the foundation upon which modern industrialism and all the moral, intellectual, technological, and therapeutical achievements of the last centuries have been built. It rests with men whether they will make the proper use of the rich treasure with which this knowledge provides them or whether they will leave it unused. But if they fail to take the best advantage of it and disregard its teachings and warnings, they will not annul economics; they will stamp out society and the human race.”

Peter Boettke is a Professor of Economics and Philosophy at George Mason University and director of the F.A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics at the Mercatus Center. He is a member of the FEE Faculty Network.